The Gold Standard | Stanley Fischer and Moral Hazard

Felix Salmon has a good post on why Stanley Fischer is not the right guy for the post of the IMF Chief. Even though it is now irrelevant because he is overaged, it is good to recall the orthodox approach that Mr. Fischer took when he was the first deputy managing director of the Fund between 1994 and 2001. Recently, I had the opportunity to go through his speech at the III Brahmananda Memorial Lecture in February 2011 in India. It is worth going into. I have only one comment on one of the nine lessons that he drew for central bankers, from the global crisis:

After having had to decide how to deal with moral hazard issues in a variety of financial crises, I have arrived at the following guide to conduct: if you find yourself on the verge of imposing massive costs on an economy – that is on the people of a country or countries – by precipitating a crisis in order to prevent moral hazard, it is too late. You should not take the action that imposes those costs. Rather in thinking through how a system will operate in a crisis, you need to take into account the likelihood of facing such choices, and you need to do everything you can in designing the system to keep that likelihood very small.

Very well. But, one small counter-question: By taking action to prevent moral hazard, a central bank might impose current costs but what about the future benefits that arise to the country or countries by the signalling effect that it sends to those whose conduct might create ‘moral hazard’ situations in future? In other words, what is the relevant time horizon to chalk up the costs and benefits?

DISCLAIMER: This is an archived post from the Indian National Interest blogroll. Views expressed are those of the blogger's and do not represent The Takshashila Institution’s view.